Investors Can Find Comfort In Hensoldt's (ETR:5UH) Earnings Quality

The market was pleased with the recent earnings report from Hensoldt AG (ETR:5UH), despite the profit numbers being soft. However, we think the company is showing some signs that things are more promising than they seem.

View our latest analysis for Hensoldt

Zooming In On Hensoldt's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, Hensoldt had an accrual ratio of -0.14. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of €153m during the period, dwarfing its reported profit of €54.0m. Hensoldt shareholders are no doubt pleased that free cash flow improved over the last twelve months. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Hensoldt issued 10.0% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Hensoldt's EPS by clicking here.

A Look At The Impact Of Hensoldt's Dilution On Its Earnings Per Share (EPS)

Three years ago, Hensoldt lost money. And even focusing only on the last twelve months, we see profit is down 31%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 31% in the same period. So you can see that the dilution has had a bit of an impact on shareholders.

If Hensoldt's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Hensoldt's Profit Performance

In conclusion, Hensoldt has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. After taking into account all these factors, we think that Hensoldt's statutory results are a decent reflection of its underlying earnings power. If you want to do dive deeper into Hensoldt, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Hensoldt has 2 warning signs and it would be unwise to ignore them.

Our examination of Hensoldt has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.